No inflation as yields jump belies point of no return view

For the first time since 2009, U.S. bond yields are rising at the same time inflation is slowing, providing a cushion for investors in Treasuries whether or not the Federal Reserve slows the pace of its debt purchases.

While 10-year yields reached 2.23% May 29, the highest since April 2012, the personal consumption expenditure deflator, the Fed’s preferred gauge of inflation, rose 0.7% in April from a year earlier, the smallest increase since 2009. The yield gap between Treasury Inflation-Protected Securities, or TIPS, and non-indexed bonds show investors have cut their expectations for consumer price increases to the lowest level since July.

After losing 2% last month, the most since December 2009, according to Bank of America Merrill Lynch bond indexes, Treasuries are offering the highest real yields in more than two years amid 7.6% unemployment. The last time yields rose while inflation slowed was four years ago, following President Barack Obama’s $787 billion stimulus plan. Yields later fell.

“We don’t think inflation is a big threat,” Andrew Wickham, head of U.K. and global fixed-income at Insight Investment Management Ltd., which oversees about $134 billion in bonds and currencies, said in a June 5 presentation in London. “It is very unlikely that we will see any major rise in interest rates for Treasuries from here.”

Bonds Rally

Wickham said he’s buying Treasuries maturing in 30 years, which would typically suffer the biggest losses if inflation accelerates, while selling those due in 10 years.

Treasury 10-year yields rose four basis points, or 0.04 percentage point, to 2.17 last week, as the government reported that the unemployment rate and hourly wages remained steady in May. Yields on 30-year bonds increased five basis points to 3.34%. The price of the benchmark 1.75% note due May 2023 dropped 12/32, or $3.75 per $1,000 face value, to 96 7/32. Yields were little changed at 8:52 a.m. New York time.

The 10-year Treasury yield reached as high as 2.23% on May 29, up from 1.67% at the end of April amid growing expectations that the Fed will begin to reduce, or taper, its $85 billion monthly purchases of Treasuries and mortgage bonds.

Bill Gross, manager of the world’s biggest fixed-income fund for Pacific Investment Management Co., said in a May 10 Twitter message that the 30-year bull market for bonds had “likely ended” as yields reached a low.